In the last two weeks of 2019 we are running material which we have primarily covered during the year but which discusses the important developments during this year. As we reflect on what has transpired during the year, let’s also think about how we can improve the tax procedure process going forward.
2017 Tax Legislation
The Tax Cuts and Jobs Act (TCJA) has already had significant effects on taxpayers in the first two years since its enactment. The law almost doubles the standard deduction for taxpayers, while mostly eliminating personal exemptions and limiting or eliminating certain personal deductions. Of particular relevance in the LITC context, the Child Tax Credit (CTC) was doubled from $1,000 to $2,000 per qualifying child (though only $1,400 is refundable). While the elimination of the personal exemption for dependents largely makes this a wash for many taxpayers, low income taxpayers may actually be advantaged by the change, since the CTC is partially refundable, and exemptions are of less benefit to those with low marginal rates. Finally, beginning in 2019, the TCJA eliminates the shared responsibility penalty assessed on taxpayers who fail to enroll in qualified health insurance plans under the Affordable Care Act.
The TCJA has also led to another potentially unintended consequence for some taxpayers seeking ITINs for their dependents. Since the dependency exemption is now worth $0 and because (almost) all tax benefits attributed to an ITIN dependent requires that they physically live in the United States (see e.g. IRC 24(h)(4)(B)), the IRS is now reluctant to issue ITINs to dependents outside of the US unless a specific tax benefit is demonstrated. (See W7 Instructions, “What’s New”). This causes serious problems for taxpayers that live in “non-conforming” states (like Minnesota) where a dependency exemption is still worth something on the state return, but their dependent lived in Mexico the whole year. These taxpayers can’t get an ITIN for the dependent because there is arguably no federal tax reason, and they can’t put their dependent on the state return because they don’t have a federally issued ITIN. The University of Minnesota LITC has dealt with this issue and had some success by working with a VITA site that issues ITINs. In at least one instance, the clinic was able to get an ITIN issued based on an issued position letter that argued that there was a federal benefit to an ITIN.
Leslie Book, Suggestions to Get Up to Speed on (Some) Issues With the New Tax Law, Procedurally Taxing (Dec. 17, 2017), https://procedurallytaxing.com/suggestions-to-get-up-to-speed-on-some-issues-with-the-new-tax-law/
Third party contacts
Until the TFA was enacted, a 9th Circuit case, J.B. v. United States, represented anew obstacle for IRS making contact with third-parties during an audit. During the course of the audit of the petitioner and his wife, the IRS issued a summons to a third-party (incidentally, the California Supreme Court), seeking information on compensation issued to the petitioner. The petitioner then moved to quash the summons, on the basis that the IRS failed to give reasonable advance notice of the third-party contact (in accordance with IRC § 7602(c)(1)) when it sent Publication 1, a pamphlet included with the initial notice of audit. Publication 1 is a generic publication that broadly gives advance notice of the possibility that the IRS will make contact with a third party.
The 9th Circuit held that the publication was insufficient as not reasonably calculated to inform the taxpayer of the contact. The court based its decision on a number of factors, including the two-year length between the issuing of Publication 1 and the contact, the possibility of privileged information being included in the summons, and the extensive contact between the taxpayers and IRS. Perhaps most relevantly, the court suggested in a footnote that Publication 1 alone may never be sufficient to provide reasonable notice due to its broad language and lack of certainty regarding the chance of contact. But see, High Desert Relief, Inc. v. United States, 917 F.3d 1170, 1193 (10th Cir. 2019) (assuming, without deciding after J.B., that Publication 1, in substance, did provide sufficient notice under section 7602(c)(1)).
Following a 2017 National Taxpayer Advocate report discussion of TPCs, Section 1206 of the Taxpayer First Act (TFA) amended IRC § 7602(c) by repealing the requirement for the IRS to provide “reasonable notice,” making J.B. less relevant. It clarified that the IRS may provide this third-party contact (TPC) notice only if it intends to make a TPC during the period specified in the notice, which may not exceed one year. Generally, the IRS must send the notice at least 45 days before making the TPC. TAS has been advocating that an IDR be included with the TPC notice so that the taxpayer has a realistic opportunity to avoid a TPC that seeks new information by providing the information requested.
See Leslie Book, Ninth Circuit Rejects IRS’s Approach to Notifying Taxpayers of Third Party Contacts, Procedurally Taxing (Mar. 4, 2019), https://procedurallytaxing.com/ninth-circuit-rejects-irss-approach-to-notifying-taxpayers-of-third-party-contacts/
EITC
Special Report to Congress
Before leaving her post as National Taxpayer Advocate, Nina Olson issued a Special Report on the Earned Income Tax Credit as part of her annual report to Congress. The report makes a number of recommendations to improve administration of the EITC, notably including that the IRS develop an examination process for EITC bans and that Congress legislate whether the Tax Court has jurisdiction over EITC ban cases. Under the current situation, taxpayers are left with little recourse or due process opportunity when the IRS imposes such a ban.
See Bob Probasco, The EITC Ban – Further Thoughts, Part One, Procedurally Taxing (Sep. 27, 2019), https://procedurallytaxing.com/the-eitc-ban-further-thoughts-part-one/
Leslie Book, EITC Ban: NTA Report Recommends Changes and IRS Advises on its Application to Partial Disallowances, Procedurally Taxing (Aug. 8, 2019), https://procedurallytaxing.com/eitc-ban-nta-report-recommends-changes-and-irs-advises-on-its-application-to-partial-disallowances/
Earned Income for EITC but not for Income Taxes
Feigh v. Commissioner involved a novel issue of law: the interplay between the exclusion of Medicaid Waiver Payments from income (a change made via notice in 2014) and the EITC. The petitioners in Feigh would have been able to exclude these received payments from their income, but it actually would have made them worse off by removing the “earned income” necessary for them to qualify for the EITC and Child Tax Credit (“CTC”). The IRS rationale was that it was preventing the provision of a double tax benefit not intended by Congress. The Tax Court applied Skidmore deference to the IRS notice changing the waiver treatment and found that the notice was not persuasive that payments were excludible under IRC 131. The court then held that the IRS could not reclassify the status of the payments via notice as a means to eliminate the benefits of the EITC and CTC.
See Caleb Smith, Invalidating an IRS Notice: Lessons and What’s to Come from Feigh v. C.I.R., Procedurally Taxing (June 17, 2019), https://procedurallytaxing.com/invalidating-an-irs-notice-lessons-and-whats-to-come-from-feigh-v-c-i-r/
Innocent Spouse
Jurisdiction of District Court to hear refund
The question of whether taxpayers can bring an innocent spouse claim as part of a refund suit is an increasingly litigated issue. Under the long-time rule of Flora v. United States, taxpayers must pay their assessment first in order to bring a refund claim in federal district court. But whether such taxpayers could litigate the merits of their innocent spouse claims in such an action has been unclear. In 2018, a Texas district rejected the argument that an innocent spouse claim could proceed in a refund suit in Chandler v. United States. But in the more recent case of Hockin v. United States, an Oregon district court allowed a refund suit involving such a claim to proceed. Hockin is set for trial in early 2020 and may prove an interesting test case for this issue. Ms. Hockin was represented by the tax clinic at Lewis & Clark and the tax clinic at the Legal Services Center of Harvard Law School filed an amicus brief in this case on behalf of Ms. Hockin.
See Sarah Lora & Kevin Fann, Innocent Spouse Survives Motion to Dismiss in Jurisdictional Fight with the IRS, Procedurally Taxing (Sep. 18, 2019), https://procedurallytaxing.com/innocent-spouse-survives-motion-to-dismiss-in-jurisdictional-fight-with-the-irs/
Carlton Smith, Another District Court Holds It Lacks Jurisdiction to Consider Innocent Spouse Refund Suits – at Least for Section 6015(f) Underpayment Cases, Procedurally Taxing (May 3, 2019), https://procedurallytaxing.com/another-district-court-holds-it-lacks-jurisdiction-to-consider-innocent-spouse-refund-suits-at-least-for-section-6015f-underpayment-cases/
Carlton Smith, Update: Can District Courts Hear Innocent Spouse Refund Suits?, Procedurally Taxing (Dec. 24, 2018), https://procedurallytaxing.com/update-can-district-courts-hear-innocent-spouse-refund-suits/
Innocent Spouse and Rev Proc.
Under Rev. Proc. 2013-34, actual knowledge of a spouse’s omission of income does not preclude equitable innocent spouse relief under IRC 6015(f). A recent case litigated by the tax clinic at the Legal Services Center of Harvard Law School has sought to reinforce the availability of equitable relief to such taxpayers. In Jacobsen v. Commissioner in the 7th Circuit, the petitioner has challenged the Tax Court’s denial of his appeal of an innocent spouse determination. The petitioner had four positive factors for relief under the statute, but the Tax Court found that his actual knowledge of embezzled income outweighed those factors thus not entitling him to relief. Oral argument was held in September 2019, and the case is currently pending. Since the oral argument in Jacobsen two additional Tax Court cases have ruled against individuals claiming innocent spouse status where there was three positive factors and knowledge was the sole negative factor. The Tax Court seems to be placing a heavy thumb on the scale when knowledge exists.
See Carlton Smith, Seventh Circuit to Hear First Case about Applying Latest Innocent Spouse Equitable Rev. Proc., Procedurally Taxing (July 30, 2019), https://procedurallytaxing.com/seventh-circuit-to-hear-first-case-about-applying-latest-innocent-spouse-equitable-rev-proc/